JAPAN’S TANKAN SLEEPER HOLD

CONCLUSION: Because we think the BOJ will keep its balance sheet on hold over the immediate-to-intermediate term, as well as our models pointing to a negative inflection in Japanese growth in 3Q, we are inclined to short Japanese equities over the intermediate term – ideally nearer to TREND resistance on the Nikkei 225 Index/on any pending TRADE line breakdown.

Not to be confused with something better reserved for an ultimate fighting octagon, the title of this note suggests that we think the solid Tankan report out of Japan overnight is additive to our view that the BOJ will maintain its reluctance to pursue incremental monetary easing over the immediate-to-intermediate term (next meeting JUL 11-12). Jumping back to the BOJ’s own Tankan Survey, the survey results suggest that the intermediate-term outlook for the Japanese economy is quite positive – at least relative to both conditions and expectations 3-6MO ago. 

  • 2Q Tankan Survey:
    • Large Manufacturers:
      • Sentiment: -1 from 4
      • Outlook: 1 from -3
    • Large Non-Manufacturers:
      • Sentiment: 8 from 5; highest since 2Q08
      • Outlook: 6 from 5; highest since 2Q08
    • All-Industry FY CapEx Growth Guidance: 4% from -1.3%; highest since 4Q07! 

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Our view that the BOJ is unlikely to ease in the immediate term stands in contrast to a growing consensus view that the BOJ is looking to expand its balance sheet at the current juncture – irrespective of the data!:

“I expect the BOJ to ease in July even after a slightly better Tankan. I don’t think it’s that relevant right now to what the BOJ is trying to do, which is to reach its inflation target. We have two new members from the private sector. They are much more sensitive to market sentiment.”

-Naomi Fink, head of Japan strategy at Jefferies Japan Ltd.

While we agree with Fink’s view that the new members on the BOJ board heighten the probability of BOJ balance sheet expansion (we made that call back on MAR 2nd), we think there is a case of Duration Mismatch to be exploited here, as both recent economic and financial market trends, as well as the BOJ’s own commentary are likely leading indicators of further BOJ inactivity for the time being.

From an economic data standpoint, recent trends in Japan’s external sector, consumer sector and manufacturing/production sector are quite positive, on balance, though it is fair to note that the most recent of the data points do show negative inflections in  the survey data (PMI, Economy Watcher’s) and in Capacity Utilization. With that being said, however, it is our view that the BOJ’s inability to meet its Asset Purchase Program targets in 10 straight operations and its own guidance from its previous meeting (APP left unchanged in JUN) will combine with the Tankan Survey results to overshadow the aforementioned inflections and keep them on hold for now.

“Japan is expected to return to a moderate recovery path as overseas economies emerge from the slowdown.”

-Statement from the JUN BOJ Monetary Policy Meeting

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A chart of Japan’s 5yr breakeven inflation rate – the slope of which having materially inflected in recent weeks – tells you all you need to know about expectations in Japan’s bond market for further BOJ balance sheet expansion over the immediate-to-intermediate term.

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In light of our below-consensus expectations for global growth – particularly in economies where Japan is exposed to on the export front (China = 19.4%; US = 15.7%), we think the  BOJ remaining on hold is marginally positive for the Japanese yen. That view is consistent with what we’ve been publishing in our recent notes on Japan, namely highlighting our anticipation of JPY strength on a TRADE and TREND basis within the context of our TAIL-duration bearish thesis on the currency (vs. the USD). Unless this time is different, further yen strength from here will be yet one more bearish factor for Japanese equities over the intermediate term (in addition to a negative inflection in growth in 3Q and delayed implementation of further monetary easing – i.e. no more “drugs” for now).

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All told, because we think the BOJ will keep its balance sheet on hold over the immediate-to-intermediate term, as well as our models pointing to a negative inflection in Japanese growth in 3Q, we are inclined to short Japanese equities over the intermediate term – ideally nearer to TREND resistance on the Nikkei 225 Index/on any pending TRADE line breakdown. Our risk management levels are included in the chart below.

Darius Dale

Senior Analyst

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